February 2010

Is that my financial advisor on the six o'clock news?
How to avoid investment scams

By Don Eberley

“It's a proprietary strategy. I can't go into it in great detail."

- Bernie Madoff

Con artists have been around since prehistoric times. One can only imagine the look on the face of the first cave man who ever excitedly unwrapped a new stone wheel, only to discover that it was square. Presumably the con artist had long since retreated to the tropics with his briefcase full of money, given the popularity of head-clubbing in those days. But I digress.

Today's financial scams are more sophisticated, sometimes avoiding detection for long periods of time. Remember Bre-X, the Canadian mining company whose shares skyrocketed on the news of a massive gold discovery? That fairy tale lasted nearly two years before it was revealed that the drilling results had been falsified. There was no gold in them thar hills.

The most infamous modern investment scam, however, was Bernie Madoff's Ponzi scheme. For nearly twenty years (or possibly thirty... only Bernie knows for sure) he maintained the appearance of operating a high-paying investment portfolio, when all he was doing was using new investors' money to reward previous investors. Minus a small cut for himself, of course.

It's enough to make you swear off investing forever. Fortunately, there are ways to protect yourself.

1. Understand what you own, or else walk away

Never invest in anything if you cannot determine how its returns are being generated. Investments which seem too good to be true, and which are wrapped in a shroud of secrecy, are the most likely to have something wrong with them.

When a hot new hedge fund was presented to me a few years ago, the company representative suggested that it would deliver consistent 6-8% returns with no declines. Strike one, I thought to myself. Too good to be true. The rep also could not elaborate on the derivatives strategy behind this Holy Grail portfolio, nor could he identify the sub-advisors who would be executing it. Strike two and three. With thousands of investments available in Canada, I threw this one on the "not recommended" pile and walked away.

Months later, the fund was front-page news. The founder of the company had disappeared, along with several million dollars from the fund. While this proves nothing about my clairvoyant abilities, it does illustrate the value of asking questions and walking away when something doesn't add up.

2. Verify the registration of your financial advisor

Every year, people are defrauded by unlicensed investment promoters, or those who conduct business outside of their sponsoring dealer. This could be avoided by simply looking up the advisor's registration on the internet.

Individuals who are licensed to sell stocks, bonds or mutual funds in Ontario are listed, along with their sponsoring dealer, on the Ontario Securities Commission website. The Financial Services Commission of Ontario offers a similar search of licensed insurance agents, who may sell segregated fund investments from various insurance companies. Go ahead and search "Eberley" on either site to see what the results look like.

It is important to note that registration is not an endorsement of a financial advisor or firm. You could still find yourself dealing with a crook. But at least dealing with a licensed crook gives you access to a regulatory process, and potential recourse against the sponsoring dealer. It also helps you avoid unlicensed crooks entirely.

3. Always make the cheque payable to a known financial institution

Many scams involve some sort of "special" investment for which payment must be made outside of the usual channels. The victim is asked to make the cheque payable to some unknown holding company, or to the individual salesperson directly, rather than to a recognized financial institution.

While some private-placement investments may be legitimately sold in this manner, this is no place for the average investor. At best, these are unsupervised transactions for which your advisor could be reprimanded. At worst, they could be fraudulent. Again, look up your advisor's registration on the internet to see which financial institution's name belongs on any cheques or agreements you sign.

With these basic precautions you can help keep your money where it belongs, instead of letting it take a one-way journey to the tropics in somebody's suitcase. Caveat Emptor.